Chile's Rainy Day Refuge

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In a region dependent on commodities, it makes sense for Latin American countries to stash away the spoils in boom times in order to have extra cash during the lean years. Chile has done an especially good job.

Ever since commodity prices began to fall last year, investors have regarded Latin America with caution. After all, the region is heavily dependent on exports of oil and gas, metals and agricultural products. With global prices for those goods falling significantly in recent months, some countries are facing declining government revenue and weaker growth. Of those most affected, there's the obvious example of Venezuela, which depends on oil for around half of its government revenue. Then there's Argentina, which is hurting from lower soy prices. Chile, too, is impacted by significant declines in copper prices.

Finding the Right Balance Between Spending and Saving

But it's not like these countries didn't know they're dependent on revenue sources that follow a boom and bust cycle. Shouldn't they have planned for this? Many countries do seem to be trying. In recent years, several in the region have created sovereign wealth funds and oil stabilization funds – including Venezuela, Mexico, Peru, Colombia and Panama. The idea is a good one: Latin American exports are largely concentrated in industries that don't offer significant job creation and are dependent on world commodity prices. It makes sense, then, to stash away some of the spoils in boom times in order to have extra cash during the lean years. And why is it so important to have extra revenue on hand? It may sound simple, but public spending is a major stimulus for growth, so it hurts economies when governments have to cut outlays in times of lower global prices.

Chiles Stabilization Fund: A Safety Net in Times of Low Commodity Prices

So which countries get good marks and which don't? If we examine the market-friendly countries in the region, there's an obvious comparison. Chile, the world's largest copper exporter, has acted with more foresight than anyone else. And oil-exporting Mexico – well, let's just say it hasn't done the same. First, let's take the former. Chile's government is required to deposit an amount equivalent to between 0.2 and 0.5 percent of the previous year's GDP into a pension reserve fund. It is also required to put a percentage of its fiscal surplus into its so-called Economic and Social Stabilization Fund. Of course, it's one thing to have rules, and another to follow them. But Chile actually does, and does so methodically. The size of the latter fund has increased from 2.6 billion dollars at its inception in 2007 to 14.7 billion dollars in December 2014.

Even with Declining Revenue, Chiles Economy Won't Suffer

There's no time like the present to have that cushion. The price of copper, which represents more than half of Chile's total exports, has fallen 12 percent to 2.6 dollars per pound since last June. That was a major reason the economy only grew 1.8 percent last year, the slowest pace since 2009. Despite the declines in revenue, the country has yet to draw on the fund or announce any spending cutbacks. It may tap the fund this year if copper keeps falling, but that wouldn't have a negative impact on the economy. "If they need to cut spending, they could fill it with proceeds from the stabilization fund," says Alonso Cervera, Credit Suisse's economist for Mexico and Chile.

Mexico Can and Should Learn from Chile Saving

Then there's Mexico, whose public spending decisions pretty much ebb and flow based on current revenues. The country, which depends on oil for roughly one-third of government revenue, spent without much reservation between 2000 and 2013. It didn't put away much of its money, and is suffering as oil has fallen 60 percent since last June. In fact, the government has cut public spending by about 0.7 percent of GDP for this year. "Mexico wishes it has a stronger oil buffer than what it has," Cervera says. "It wouldn't need to cut spending that much if it could draw on a fund."

Saving for a Rainy Day Makes All the Difference

The moral of the story? Countries that are heavily dependent on commodities exports shouldn't spend in a manner that's too pro-cyclical, like Mexico does. "When times were good, Mexico spent significantly; now it is retrenching, after oil prices have fallen 50 percent," Cervera says. "Whereas in Chile, government spending has not been a function of how much revenue is coming in." The proof is in the numbers. Chile's fund equaled 5 percent of GDP at the end of last year, while Mexico's oil fund only held 44 billion pesos (3.0 billion dollars), equal to a mere 0.2 percent of GDP. "If Mexico had 5 percent of GDP saved in an oil fund, that would make a huge difference to its economy," Cervera says. "You have to save for a rainy day."

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